THE BEST AND THE BRIGHTEST REDEFINE THE CORPORATION

Since the dawn of time, man has told stories. And at least since the start of recorded history, man has told – and written – fables. Fables, along with parables, are stories that teach moral lessons. They are the means by which children in particular are taught what matters in a particular civilization. They are the means, in short, by which the values of a civilization are transmitted from one generation to a next.

Jesus and Cicero didn’t tell parables because they were crazy old codgers who liked to see people’s reactions or hear their laughter. Aesop didn’t tell fables because they made him feel warm and fuzzy inside. All of these people – and countless others, of course – told these tales and pushed these morals because they mattered, because this was, is, and ever shall be the best means by which to inculcate every generation with the ideas, values, and norms that matter to a society. As Aristotle and C.S. Lewis remind us, the little human animal must be taught the virtues that are important. For if he is not, he will not develop those virtues and he will never understand, much less enjoy the good life.

Thirty years ago, our old (but not forgotten) friend, Claes Ryn penned a piece titled “The Humanities and Moral Reality,” in which he made the case that this type of storytelling, this means of teaching virtue was the most important of all acts in the preservation of a civilization. Ryn argued that the most important warriors in our fight to preserve our society and our civilization are the people who “draw us into their way of experiencing the world,” the nation’s artists, authors, entertainers, and advertisers. He patiently explained that an individual’s view of the world is shaped to an enormous degree by the artistic symbols to which he or she is exposed. Some such symbols strengthen character and imagination, and in doing so promote a keener sense of reality. Others, by contrast, destroy character and weaken an individual’s ability to reason.

This, Ryn said, explains why some people seem to cling so tenaciously to economic and social doctrines that have been discredited time and again by both experience and theory. There is, of course, no end to examples of this phenomenon. Common cases in point include insistence by many people on higher and higher taxes, despite overwhelming evidence that nations with moderate tax rates are more prosperous than those with very high rates; resistance to real welfare reform, despite overwhelming evidence that the program has become highly pernicious for many of the very people it was designed to help; and support for educational policies that overwhelming evidence demonstrates are directly responsible for the decay the system has suffered over the past several decades.

This strange behavior isn’t necessarily a function of low intelligence, Ryn said. “In this century alone,” he added “one can point to many individuals of obvious intelligence who have spoken foolishly on some subject. A number of Nobel prize winners come to mind who have combined genius in some field with naiveté in others.” And it certainly isn’t that the practical arguments in their favor are decisive. The explanation, Ryn said, lies in the framework from which people view things. And this framework is dictated not by politics, but by art, music, literature, television, movies and advertising; by the symbols that inspire and shape the public’s imagination and its dreams for the future.

The article in which Ryn set forth these ideas does not offer specific examples of the enormous social, and ultimately political, power of literature and the arts. But such examples abound in world history. Obvious ones include the Old Testament stories of Abraham, Ruth, Esther, Job, Jacob, David, Noah, and of course, Adam and Eve, which have profoundly shaped the very nature of Western society. Erasmus’ great satire, Praise of Folly, did as much to erode respect for the local hierarchy in the medieval church as did Luther’s Ninety-Five Theses. Shakespeare and Milton changed the way the world thinks about conflict and love and honor and God. Voltaire and Rousseau can take as much responsibility for the French revolution, which changed the Western world forever, as the actions of Louis XVI or Marie Antoinette.

In more recent times, Harriet Beecher Stowe’s novel Uncle Tom’s Cabin also comes to mind. It had as much impact on the debate over slavery, and probably influenced the resort to war, more than all of the debates in Congress combined. Steinbeck’s Grapes of Wrath and In Dubious Battle had an enormous impact on the way millions of Americans viewed both the American labor movement and the early liberal agenda. Leon Uris’s Exodus affected the attitude of untold Christian Americans toward the new state of Israel. And many of the most vociferous opponents of the death penalty still cite Camus’ Reflections on the Guillotine, as having changed their lives.

Today, we are grappling with the following questions: What happens when a civilization can no longer agree on the values that should be passed down from one generation to the next; when it no longer has any idea what constitutes good and proper behavior and therefore can no longer agree on the virtues that should be taught to its to children? What happens when the collective wisdom of the ages is jettisoned, not just by one man or one group, but by a society as a whole? What happens when fables are no longer told. When they no longer carry any resonance because a society no longer has any shared values?

The answers to these questions are, we think, obvious. And yet it appears that we – as a society – will have to learn them all again. The hard way.

As you may have heard, on Monday, the Business Roundtable issued a document in which it purported to redefine the purpose of a corporation. No longer shall corporations be dedicated exclusively to profit and thus to the interests of their shareholders. Instead, publicly held companies will judge themselves in terms of ALL of their “stakeholders,” a group that includes everyone and everything from shareholders to employees, from customers to Mother Earth herself. In a piece for Fortune magazine, Alan Murray described the change as follows:

For Milton Friedman, it was simple. “There is one and only one social responsibility of business,” the Nobel economist wrote in 1970: to “engage in activities designed to increase its profits.” Companies must obey the law. But beyond that, their job is to make money for shareholders. 

And Friedman’s view prevailed, at least in the United States. Over the following decades, “shareholder primacy” became conventional business wisdom. In 1997, the influential Business Roundtable (BRT), an association of the chief executive officers of nearly 200 of America’s most prominent companies, enshrined the philosophy in a formal statement of corporate purpose. “The paramount duty of management and of boards of directors is to the corporation’s stockholders,” the group declared. “The interests of other stakeholders are relevant as a derivative of the duty to stockholders.” Times change.

On Aug. 19, the BRT announced a new purpose for the corporation and tossed the old one into the dustbin. The new statement is 300 words long, and shareholders aren’t mentioned until word 250. (Scroll to the bottom of this page to read the statement in its entirety.) Before that, the group refers to creating “value for customers,” “investing in employees,” fostering “diversity and inclusion,” “dealing fairly and ethically with suppliers,” “supporting the communities in which we work,” and “protect[ing] the environment.”…

The new statement is the result of a yearlong reexamination that began with a testy dinner attended by a group of journalistic critics and involving a comprehensive survey of CEOs, academics, NGOs, and political leaders. “It has been a journey,” says Johnson & Johnson CEO Alex Gorsky, who chaired the effort. But it was a necessary journey because “people are asking fundamental questions about how well capitalism is serving society.” 

JPMorgan Chase CEO Jamie Dimon, who chairs the Roundtable, said the statement “is an acknowledgment that business can do more to help the average American.”

Now, on the one hand, it is probably wise to take this statement from the Business Roundtable with a grain of salt. This is a PR document more than anything else. What these CEOs are advocating is, in practice, little different from what they have been doing for decades anyway. The wise CEO is already concerned with stakeholders other than shareholders. This is how businesses become profitable and stay profitable over the long-run, after all, by planning strategically, protecting their reputations, and by ensuring that they will benefit from the goodwill of the marketplace. All the Business Roundtable is doing here is sending this message in terms that would appear to placate the populist sentiment – on both the Left AND the Right – that has been growing over the last several years and that sees big corporations as the locus of all that is evil in the world.

On the other hand, it is also quite clear – given the players involved and the language used – that this is intended to be a political document, a pre-emptive indemnification on the part of a number of powerful men and women to use their positions of power to do as THEY see fit, with respect to the company, its interests, and various external constituencies. If their actions cause a dip in share-price; if their attempts to satisfy a political constituency or to prevent “reputational risk” prove damaging to their business model in the short term, then they can and WILL fall back on this “stakeholder model” for justification. We did what we did because, in our judgment, it was the RIGHT thing to do for the largest number of stakeholders.

In the wake of the Business Roundtable’s declaration, we have seen two explanations for the explicit change in the definition of a corporation. The first of these was set forth by Matt Levine at Bloomberg Opinion and suggests that what we have here is a case of managers – CEOs, etc. – deciding that sometimes, shareholders are a pain in the backside. They are declaring their independence to do what is right, even when the shareholders are wrong. Levine put it this way:

[T]he corporation really does have to serve many different stakeholders, but in practice most disputes over corporate governance are not between shareholders and employees or shareholders and polluted watersheds, but between shareholders and managers. And these disputes tend to follow a stereotyped pattern in which disgruntled shareholders say “the stock price is low” and the managers say “ah but in the long term it will be high.” Because — on the agency-cost view — it is just harder to measure the long term (since it hasn’t happened yet), so you can’t hold the managers to it. Similarly, if managers can respond “ah but the stock price is low because we are serving other constituencies,” that gives them another argument against the shareholders.

It is productive — not 100% accurate, but a useful heuristic — to assume that all corporate governance debates in the U.S. are about whether shareholders or managers should have more power to control the corporation. There are other stakeholders, sure, but they are mostly tools in the shareholder/manager fight, not power centers in themselves.  So when an association of big public-company CEOs gets together and declares that corporations should serve the community, take care of the environment, and be responsible to employees and customers, not just shareholders, that might be because the CEOs have thought it over and decided that employees and the environment are getting a raw deal, but it is also possible that the CEOs have thought it over and decided that shareholders are annoying.

The second explanation for the BRT’s new position is the more prevalent one and one that we will call “Churchill’s Crocodile,” in reference to the statement that Reader’s Digest adapted from a speech Churchill gave in 1940: “An appeaser is one who feeds a crocodile — hoping it will eat him last.” The idea here is that the CEOs of the Business Roundtable are trying to placate the leftist mob in all its various forms – customers, shareholders, employees, etc. – in in the hope that the activists will allow them to run their companies without leftist interference. Yesterday, the editorial board of the Wall Street Journal put it this way:

There is also more than a whiff of pre-emptive politics here. The executives — the Business Roundtable is led by JPMorgan CEO Jamie Dimon —know they are political targets.

They see socialism on the rise, with Senator Elizabeth Warren proposing to redefine corporate governance in law with explicit direction to serve “stakeholders.” Her goal is to redirect corporate capital to serve political goals favored by unions, environmentalists and trial lawyers. The CEOs no doubt want to get out in front of this by showing what splendid corporate citizens they are.

Yet these CEOs are fooling themselves if they think this new rhetoric will buy off Ms. Warren and the socialist left. It may even embolden them by implying that corporate rules that require a focus on achieving value for shareholders are somehow morally insufficient. The Roundtable CEOs may be selling Ms. Warren the political rope to hang them.

Our friend Justin Danhof, the General Counsel for the National Center for Public Policy Research and the Director of the Free Enterprise Project, concurred, suggesting that the Business Roundtable may think it has done something clever but all it has really done is make its member companies more likely targets. He wrote:

This WILL open them up to a slew of shareholder resolutions. BRT is playing right into the activist’s hands. 

Many liberal proposals follow a predictable pattern. Step 1) file a resolution seeking a policy statement on some ESG issue. Step 2) The left then “identifies” an action that is out of step with the policy statement. Step 3) file a resolution the following year that demands the corporation stop the action identified in Step 2 because it is incongruous with the policy statement in Step 1. 

Here’s the kicker - often times the action in Step 2 is being a member of a pro-business association such as BRT! ... What BRT just did was to put Step 1 in writing for the whole world to see, essentially doing the first part of the left’s job in the process. Ugh. I can actually envision resolutions now demanding companies leave BRT because some BRT advocacy offends this BRT statement.

Both of these explanations – “The Rebellious CEOs” and “Churchill’s Crocodile” – make a great deal of sense. Danhof, who is in the trenches of this fight every day, knows whereof he speaks. And if he says that this is a foolish move on the part of foolish CEOs who are just borrowing trouble, then we are inclined to think he’s right.

All of that said, we have our own thoughts on the subject, which combine elements of the first two but which also hint at much larger and much more systemic issues with capital markets and the politicization of them. And as you might have guessed, given our introduction to this piece, our thoughts start with a fable, “The Miller, His Son, and the Ass.” To wit:

One day, a long time ago, an old Miller and his Son were on their way to market with an Ass which they hoped to sell. They drove him very slowly, for they thought they would have a better chance to sell him if they kept him in good condition. As they walked along the highway some travelers laughed loudly at them.

“What foolishness,” cried one, “to walk when they might as well ride. The most stupid of the three is not the one you would expect it to be.”

The Miller did not like to be laughed at, so he told his son to climb up and ride.

They had gone a little farther along the road, when three merchants passed by.

“Oho, what have we here?” they cried. “Respect old age, young man! Get down, and let the old man ride.”

Though the Miller was not tired, he made the boy get down and climbed up himself to ride, just to please the Merchants.

At the next turnstile they overtook some women carrying market baskets loaded with vegetables and other things to sell.

“Look at the old fool,” exclaimed one of them. “Perched on the Ass, while that poor boy has to walk.”

The Miller felt a bit vexed, but to be agreeable he told the Boy to climb up behind him.

They had no sooner started out again than a loud shout went up from another company of people on the road.

“What a crime,” cried one, “to load up a poor dumb beast like that! They look more able to carry the poor creature, than he to carry them.”

“They must be on their way to sell the poor thing’s hide,” said another.

The Miller and his Son quickly scrambled down, and a short time later, the market place was thrown into an uproar as the two came along carrying the Donkey slung from a pole. A great crowd of people ran out to get a closer look at the strange sight.

The Ass did not dislike being carried, but so many people came up to point at him and laugh and shout, that he began to kick and bray, and then, just as they were crossing a bridge, the ropes that held him gave way, and down he tumbled into the river.

The poor Miller now set out sadly for home. By trying to please everybody, he had pleased nobody, and lost his Ass besides.

Our suspicion is that the CEOs of the Business Roundtable – the new Masters of the Financial Universe – believe that they can do anything they want to do, that they are capable of feats that no mere mortal could manage, chief among which is the ability to please everyone. BRT Chairman Jamie Dimon – also the CEO of JP Morgan – is likely to feel especially omnipotent. After all, he steered Morgan through the Great Recession, the greatest financial disaster in nearly eight decades. And all it took was a wave of his hand. And $25 billion in taxpayer-provided troubled asset relief. Why should he worry that he is spreading himself or his company’s assets too thin? He is too big to fail, after all.

The CEOs of the Roundtable believe – which is to say know – that there is no one in the world who wants them to let their shareholders down. They know that their regulators, their accountants, the Federal Reserve, and especially the kind and generous men and women who serve this great nation as elected officials in our federal government want for their companies’ share prices to remain as high as possible for as long as possible. And that means that the CEOs can do whatever they want, including finding ways to satisfy various “stakeholders” without actually having to worry about what such extraneous activities will do to their business models. They have it made. They’re ALL too big to fail.

If the Fed doesn’t do its job of providing endless supplies of money for everyone at all times, then someone else will, of course. The President, for example, will cut payroll taxes. Or he will index capital gains taxes to inflation. Or he won’t. Or he, in conjunction with the spendiest Congress in the history of ever, will enact budget deals with one-and-a-half-trillion dollar DEFICITS as far as the eye can see. There is no reason for any CEO to worry. There’s money aplenty. We own the printing presses. And we will print as much of it as is necessary to keep your stock prices high and your shareholders happy, even as you spend frivolously on non-business-related social-justice activities or focus on other, undefined “stakeholder matters.”

The simple truth of the matter is that the constant, ongoing, and presumably never-ending access that major corporations have to exceptionally cheap capital makes pleasing everyone at all times seem plausible and, moreover, perfectly sensible. If we can continue to keep our balance sheets looking stellar – through manipulation and access to easy money – then we can keep shareholders happy, we can keep management happy, we can keep employees happy, we can keep elected officials happy, and we can engage in a little politicking on the side because…why not? Who is going to complain?

The problem here is that eventually, something has to give. Eventually, the Fed will have to acknowledge that it has strayed far from its mission and – guess what! – inflation is suddenly a serious issue. Or eventually, investors will figure out that a company’s profit-margin growth does not equate to increases in sales or productivity and is being accomplished using dirt-cheap money invested elsewhere. Or eventually, it will become clear that stock buybacks enabled by cheap money will keep shareholders and management happy but do not constitute a long-term corporate strategy. Eventually, something has to give. And when it gives, some, maybe all, stakeholders will suffer. And it will no longer be “easy” to please everyone. And yet some managers, at some companies, will continue to try, even as it becomes harder and harder to do. And this will lead, inevitably, to even bigger issues and a bigger “something” giving.

If you’d like an example of how this happens and what happens next, we direct you to “Repo 105” and the onetime employer of ours formerly known as Lehman Brothers. In October of last year – on, roughly, the tenth anniversary of Lehman’s collapse – Ben Hunt over at Epsilon Theory penned a piece explaining what Repo 105 was, how it used by Lehman, and how it contributed to the company’s spectacular demise and the resulting financial crisis. Those of you who read Ben’s stuff may think that the above section has probably been heavily influenced by his work. And you’re right! But he’s right too! And there are ALWAYS risks associated with trying to please everyone, shareholders included, when a company’s business strategy or business acumen doesn’t permit it. And Repo 105 was one such example. Or, as Ben put it:

Repo 105 was a multiyear scheme by Lehman to defraud the government and its own investors by falsifying the actual amount of loans it had on the books, making Lehman look safer than it actually was.

It worked like this. A few days before the end of the calendar quarter, Lehman would “sell” billions of dollars worth of loans to another bank. I put “sell” in quotation marks, because Lehman ALSO had an agreement with these other banks to buy the loans back a few days after the quarter ended for the same price as they were sold, plus enough money to cover whatever the going interest rate was on that cash for the few days it was in Lehman’s hands. This is what’s called a repurchase agreement, or repo, hence the name Repo 105 (the 105 refers to the 5% overcollateralization that counterparty banks required to lend the cash to Lehman even for a few days – they knew Lehman was in trouble). Since financial reporting happens at the end of the quarter, Lehman’s books would look like they had more cash and fewer loans than they actually did.

Surely, you say, no law firm would bless this blatant attempt to cook the books? And I say, don’t call me Shirley. I say, well … no US law firm would bless this, so naturally Lehman found a UK firm, Linklaters, to say that this was, in fact, technically a “true sale”. Even then, to pull this off Lehman had to run Repo 105 through their offshore subsidiaries, not through their US-chartered entities. It was really expensive for Lehman to run Repo 105. But also entirely necessary, or else the entire house of cards that WAS Lehman would have collapsed well before September, 2008.

What about Lehman’s auditors, you ask, surely no auditor would go along with this scheme? Again … Shirley. Again, Lehman found that Ernst & Young would indeed sign off on the program, in exchange, of course, for a sharp increase in fees. The state of New York filed civil fraud charges against Ernst & Young over Repo 105 in December, 2010. I believe they paid a (small) fine.

Dick Fuld claims that he knew nothing about the Repo 105 program. The only possible answer to this, and here I’ll apologize in advance for my language, but it’s really the best possible word – bullshit. Did I mention that Repo 105 was a really expensive program to run? Did I mention that Dick Fuld’s nickname was The Gorilla, that he was infamous for controlling everyone and everything at Lehman? Did I mention that Repo 105 was concealing existential risk for Lehman?

If you or I did what Lehman did with Repo 105, we would be charged and convicted of bank fraud. Happens all the time. It’s pretty much what Paul Manafort just got convicted on. This is a crime. It is not a minor crime. It’s an absolute slam-dunk case for any prosecutor in any jurisdiction in the country. And yet, with the exception of the civil fraud charges brought against Ernst & Young, no other charges – civil or criminal – were ever filed by the SEC or the Justice Department in connection with Repo 105.

You take the moral hazard introduced by the fact that no one anywhere ever went to jail for any of the chicanery associated with the financial collapse and the Great Recession; you add in a HUGE heaping of cheap money; you add a dollop of politicization of everything, including capital markets; and then, just for fun, you sprinkle in an attempt by the nations Best and Brightest financial minds to please everyone, including political activists and shareholders simultaneously; and what you wind up with is a recipe for disaster.

Yes, some of what the Business Roundtable did was out of sheer annoyance with shareholders. And yes, an even bigger part of what it did was an attempt to appease the ESG/social investing crocodile. But the biggest part of it, in our estimation, is the belief on the part of the Best and Brightest that they can do the erstwhile impossible. They can please everyone.

In the end, of course, as anyone who puts faith in fables and ancient virtues can tell you: we will ALL lose our asses.

Copyright 2019. The Political Forum.